By Evelyn S Devadason
ASEAN has little difficulty attracting foreign capital. The harder question is what happens after it arrives.
Foreign direct investment (FDI) has been integral to Southeast Asia’s industrial ascent, bringing capital, technology and access to international markets while embedding the region in global value chains (GVCs). The momentum remains strong: FDI inflows into ASEAN reached about US$246 billion in 2025.
Behind that headline number, however, lies a more complicated picture of regional integration. Intra-ASEAN investment accounted for about 16.1% of ASEAN’s inward FDI in 2025. From 2012 to 2025, calculations based on ASEANstats data indicate that intra-regional FDI grew at an annual rate of 6.4%, compared with 8.7% for ASEAN’s total inward FDI from the world. Regional investment has expanded, but not as rapidly as ASEAN’s overall ability to attract foreign capital.
The geography of these flows is equally revealing. Based on preliminary ASEANstats data for 2025, Singapore alone received 61.5% of global FDI into ASEAN, followed by Vietnam (9%), Indonesia (8.7%), Thailand (7.8%) and Malaysia (6.3%). Intra-ASEAN investment followed a markedly different pattern: Malaysia was the largest recipient, accounting for 32.6% of intra-regional inflows, followed by Vietnam (18.3%), Thailand (18.2%) and Indonesia (15.2%).
These patterns point to a larger question. ASEAN has become exceptionally successful at attracting global capital, but attracting investment is not the same as acquiring the capabilities embodied in it. An economy can produce semiconductors, electric vehicles (EVs), batteries or sophisticated electronics without controlling the technologies, design, intellectual property (IP) or strategic functions that account for much of their value.
This concern is increasingly visible in national policy debates. Malaysia’s investment policy, for example, is shifting towards outcome-based incentives and greater emphasis on domestic supply-chain linkages, productivity, technology, skills and higher-value employment. As Malaysia prepares Budget 2027, the question is becoming less about how much investment can be attracted and more about what that investment leaves behind in the domestic economy. The same question applies more broadly across ASEAN.
ASEAN’s challenge is therefore changing. FDI has clearly contributed to industrialisation, the issue now is the depth of the transformation it produces. Put more sharply: Is ASEAN’s next phase still about FDI-led industrialisation or must it become one of FDI-led capability development?
Foreign Investment, Domestic Divide
One legacy of ASEAN’s FDI-centred development model is a persistent divide between foreign and domestic firms. On one side are highly productive multinational enterprises (MNEs) connected to technology, capital and international markets. On the other are large numbers of domestic firms, particularly small and medium enterprises (SMEs), with lower productivity, weaker technological capabilities and much thinner connections to international production networks. A world-class foreign-owned factory can therefore operate alongside domestic enterprises that have little connection with it beyond basic services or low-tier supply. The productivity of the former does not automatically migrate to the latter.
This is why spillovers matter. They can occur when MNEs develop local suppliers, enter partnerships with domestic companies, train workers who subsequently move across the economy, or induce local competitors to improve. But these channels depend on domestic firms having sufficient technological, financial and human capabilities to respond. FDI’s wider developmental impact therefore depends not simply on what happens inside the foreign affiliate, but on what changes around it.
This divide also complicates what it means for ASEAN to “move up the value chain”. An economy may enter more sophisticated industries, perform higher-value functions within those industries or develop stronger domestic firms capable of competing internationally. These are related but distinct forms of upgrading.
Sectoral upgrading occurs as investment moves into activities such as electronics, semiconductors, EVs and batteries, machinery and sophisticated services, reshaping the region’s production structure and potentially creating new sources of comparative advantage. Functional upgrading goes further. Producing an advanced product does not necessarily mean performing its most valuable functions. The more demanding transition is, from processing and assembly towards engineering, software, design, research and development (R&D), data analytics and other knowledge-intensive activities.
Domestic upgrading asks who ultimately acquires these capabilities. Can ASEAN-owned firms progress from peripheral suppliers to technologically capable producers, develop their own IP and eventually become regional or international investors?
The three forms of upgrading need not occur together. An economy can enter a sophisticated industry while remaining concentrated in relatively routine functions; it can even acquire higher-value functions while domestic firms remain weak. The issue is therefore not simply whether ASEAN is moving up the value chain, but how upgrading is occurring, who benefits from it, and how much of the resulting capability becomes embedded within the region.
One ASEAN, Uneven Gains
The same conundrum plays out across ASEAN itself. MNEs increasingly view Southeast Asia as a production space rather than ten isolated national markets. Yet the functions distributed across that space are not equal in value. R&D, finance, design, software, headquarters functions and data-intensive activities may cluster in a handful of locations, while other economies specialise in components, processing, assembly and logistics.
Specialisation itself is not the problem; it is fundamental to efficient regional production. The concern is whether today’s division of labour hardens into tomorrow’s hierarchy, leaving some ASEAN economies persistently concentrated in lower-value functions.
This raises a broader question about regional integration. Is ASEAN becoming an integrated production system, or a collection of national production locations connected more strongly to MNEs headquartered outside Southeast Asia than to ASEAN firms themselves? The relatively modest role of intra-ASEAN investment offers one indication. Production has become highly regionalised, but ownership of the firms organising that production is much less so.
Northeast Asian investment provides a useful test of this regional model. FDI inflows from the Plus Three economies, China, Japan and South Korea, reached US$45 billion in 2025, which is equivalent to almost one-fifth of all FDI entering ASEAN. Their significance, however, extends well beyond the amount of capital they provide. Firms from these economies have played major roles in shaping production and supplier networks across Southeast Asia.
Japan presents the longest-running test. Japanese investment has been instrumental in developing ASEAN’s automotive, machinery and electronics industries and extensive cross-border supplier networks. After decades of such investment, however, the benchmark for success needs to be more demanding. The question is how far ASEAN firms have used these relationships to acquire technology, develop products and progress into engineering, innovation and other higher-value functions. Japan therefore provides a test of what mature foreign production networks ultimately leave behind in indigenous capabilities.
South Korea presents a different test. Investment organised around large lead firms has helped create major manufacturing clusters, particularly in electronics, while drawing extensive supplier networks into the region. Yet a technologically sophisticated cluster does not necessarily imply an equally sophisticated domestic corporate base. If lead firms are accompanied mainly by established foreign suppliers, ASEAN can acquire a highly productive export industry without generating a comparable ecosystem of locally owned firms. The Korean case therefore tests whether foreign-led clustering can become a platform for ASEAN-owned supplier development.
China presents the newest and perhaps most dynamic test. Chinese firms are investing abroad after accumulating substantial manufacturing, technological and organisational capabilities at home. At the same time, trade tensions, changing costs, geopolitical uncertainty and supply-chain diversification are reorganising production across Asia. ASEAN has emerged as an important destination for this adjustment, particularly in electronics, EVs and batteries.
In some industries, this represents more than a movement of capital; it is a reconfiguration of China-centred production networks. Chinese lead firms may establish factories in ASEAN, suppliers may follow, intermediate inputs may continue to arrive from China, and the resulting products may be sold within the region or exported to third markets. The critical question is whether Chinese FDI is creating new comparative advantages for ASEAN or relocating Chinese comparative advantages into ASEAN.
The distinction depends on what becomes embedded locally. If production moves while critical technologies, sophisticated inputs, R&D, IP and strategic decision-making remain elsewhere, ASEAN gains industrial capacity but a narrower set of capabilities. If investment instead generates competitive local suppliers, engineering expertise and technological learning, the developmental impact is much deeper.
The three experiences therefore pose different tests: Japan raises the question of capability accumulation over time; Korea, the depth of local supplier development; and China, the localisation of capabilities as production networks are being reconfigured.
The Chinese case also illustrates why investment and trade are increasingly difficult to separate. New investment can generate imports of machinery and intermediate inputs, production within ASEAN and subsequent exports to regional or third-country markets. At the same time, established supplier clusters, logistics networks and trading relationships can attract further investment. The relationship therefore runs in both directions.
What matters is not simply how much trade follows FDI, but how much value is added within ASEAN, which functions are performed locally and whether ASEAN suppliers become more productive through their participation.
Foreign Capital, ASEAN Ownership
The prominence of foreign investors raises another question: where are ASEAN’s own firms in this transformation?
Continued success in attracting foreign companies should not substitute for developing strong domestic investors. Dependence on multinational production networks inevitably creates exposure to decisions made elsewhere, as lead firms adjust technologies, suppliers and production locations in response to commercial and geopolitical conditions.
The answer is not less FDI, but a stronger domestic investment base alongside it. Domestic direct investment (DDI) matters because firms need to build capabilities at home before they can become competitive suppliers, exporters and eventually outward investors. As these firms expand across ASEAN, they can contribute to more regionally owned production and service networks. FDI, DDI and intra-ASEAN investment should therefore be seen as complementary: Foreign investment provides access to capital, technology and markets; DDI strengthens the domestic firms able to absorb these opportunities; and intra-regional investment allows successful ASEAN firms to scale across the region.
The deeper measure of regional integration is therefore not simply how extensively production crosses ASEAN borders, but whether ASEAN firms themselves acquire the capacity to invest, innovate and compete across the region.
From Factories to Capabilities
Investment policy must evolve accordingly. For decades, success could be expressed relatively straightforwardly: investment dollars attracted, factories established, exports generated and jobs created. Those indicators remain important, but they reveal relatively little about whether FDI strengthens the productive capabilities of the host economy.
Investment incentives should increasingly reward outcomes rather than commitments, giving greater weight to supplier development, workforce training, R&D, collaboration with domestic firms and universities, and the location of more sophisticated functions within ASEAN.
Employment policy requires a similar shift. The relevant question is no longer simply how many jobs an investment creates, but what kinds of jobs it creates and what workers learn from them. Engineering, technical, digital and managerial capabilities can spread beyond the original investor as workers change firms, establish businesses and transfer knowledge across the economy.
The same logic should extend beyond the factory floor. A growing share of value in manufacturing is created through manufacturing-related services, including R&D, engineering, software, design, testing and certification, data analytics, logistics, finance, maintenance and after-sales support. Moving into sophisticated manufacturing therefore needs to be accompanied by stronger services around production. This creates opportunities for regional service networks, in which specialised activities are connected across ASEAN rather than replicated in every economy.
MedTech provides one example. Device production in one location can connect with software development, testing, regulatory expertise, data analytics, equipment maintenance and other specialised services elsewhere in the region. Different ASEAN economies can therefore participate in different parts of the same ecosystem while progressively moving into higher-value activities.
Creative industries offer another model. Film, animation, gaming, music, advertising and digital content can connect content creation in one ASEAN economy with post-production, software, financing, distribution and digital-platform services in others. Unlike conventional manufacturing networks organised largely around movements of intermediate goods, these networks depend increasingly on flows of knowledge, creative inputs, data and specialised services.
For ASEAN, the next generation of regional value chains (RVCs) may therefore involve not only production-sharing but capability-sharing. Manufacturing-related services can deepen the value retained around existing industrial activities, while MedTech and creative-industry networks provide additional routes into knowledge-intensive and digitally deliverable activities.
ASEAN’s FDI story is not one of failure. Quite the opposite. Its success in attracting multinational investment is precisely why the policy question can now become more demanding. The first phase was about bringing global production to Southeast Asia. The next must be about ensuring that more of the knowledge, technology and productive capabilities associated with that investment take root within the region.
That requires a different scorecard. Not simply how much FDI arrived, but whether DDI grew alongside it and what capabilities remained. Not simply how many factories opened, but how many domestic firms moved up with them. Not simply how many jobs were created, but what workers learned. And not simply how deeply ASEAN participates in RVCs and GVCs, but how much value and capability ASEAN firms capture within them.
That may be the real FDI conundrum facing ASEAN: After decades of successfully attracting global capital, can the region convert foreign investment into capabilities that make its development progressively less dependent on foreign capital?
The author is a Professor at the Faculty of Business and Economics, Universiti Malaya, and Vice-President of the Malaysian Economic Association
